Financial Literacy: Lip service

July 24, 2012

Neither the regulators, nor the states want to touch the biggest scourge of savers across India: pyramid schemes

Sucheta Dalal

On 15th July, the “National Strategy for Financial Education” prepared by a sub-committee of the Financial Stability Development Council (FSDC) was released in July by various financial regulators. This paper has one passing mention of what are known as Ponzi schemes/ Pyramid schemes or multi-level marketing schemes (MLM). Yet, a little ground-up homework would have shown that from the poorest villages of Orissa, or the slums of Mumbai, to the farmers in India’s interiors, it is the lure of doubling their money that is looting ordinary, gullible people. This suggests that the government’s mega-financial literacy plan is not so concerned with protecting ordinary savers from conmen and their dubious companies, but with promoting risky equity investment that is necessary to help public and private sector companies tap people’s savings.

While millions of investors have vanished from the capital market in the past two decades, Ponzis have thrived. In effect, investors have fled from the stock market, thanks to various scams, increased entry barriers mandated by regulators and complex trading systems (KYC, dematerialisation, automation and rolling settlements) into the arms of unregulated Ponzis, which promise extraordinary returns for the simple effort of enrolling new investors through a simple binary matrix (1:1). The larger Ponzis are extremely sophisticated, have global operations and make excellent use of electronic fund transfers offered by banks to move money swiftly into core accounts and then out of India. They are structured as peddling false products and services, such as filling out online surveys or clicking on Internet advertisements, to earn extraordinary returns. Social media also helps in reaching out to a bigger swathe of Indians rapidly.

VC Sajjanar, DIG of Police, Hyderabad, who has done stellar work in shutting down several Ponzi scams, estimates that there are over 10,000 such schemes in each Indian state; but he is fighting the battle alone. There is a law that is supposed to cover pyramid schemes. It is called Prize Chits and Money Circulation Schemes (Banning) Act, 1978. The law was promulgated only after large-scale loot by these dubious companies and a report by the James Raj committee (1974) called for a total ban on such schemes arguing that they were prejudicial to public interest. It is clear the Act has failed in the 35 years thereafter, barring sporadic action by exceptional police officers like Mr Sajjanar. Meanwhile, the law minister tells parliament that SpeakAsia, the survey company, collected Rs1,300 crore from 12 lakh persons in less than a year—but it leads to no action against Ponzis.

The government continues to waffle about tightening legislation. The ministries of finance and consumer affairs are ‘studying’ the havoc wrought by pyramid schemes but doing nothing. A recent media report suggests that an FSDC committee comprising financial regulators discussed the problem but left it to ‘state governments’ to deal with it.

Meanwhile, some states, under pressure from an irate populace cheated by multiple pyramid scams, have begun to frame their own legislation. Meghalaya has a policy to deal with rampant cheating of people (its circular says the schemes are destroying the social fabric of the state) while the governments of Rajasthan, Gujarat and Kerala are working on it.

Former expenditure secretary EAS Sarma, has written to the prime minister (PM) as well as the ministry of company affairs (MCA) saying, “these pyramid companies are a scourge to any economy and they are known to have destabilised the financial systems elsewhere.”

Moneylife too has been campaigning for effective action against these schemes. In our view, the government refuses to act because MLMs have become an important source of political funding and a means to launder money. A great example is West Bengal. A senior minister told us how, in a state like West Bengal, MLM promoters have powerful political contacts and own several media establishments. The foreign lobby is equally powerful and is pushing hard for legitimising what are called ‘Direct Selling Schemes’ which otherwise fall foul of the Prize Chits Act.

How does the government rationalise its inaction? By raising a bunch of irrelevant issues. For instance, the MCA says, “MLM per se is not illegal.” This is contrary to the statute as well as the Supreme Court which has clearly ruled in the Kuriachan Chacko Vs State of Kerala that ‘money circulation schemes’ under the Prize Chits Act are those where returns are linked to enrolment of new members to the scheme. A Madras High Court judgement of 2005 (M/s Apple FMCG Vs Union of India) says that “the Executive and law enforcing authorities keep a blind eye on such activities. This also does not make an illegal act legal. It is always a fact that the law enforcing authority would try to close the stable only after the horse had escaped.” (Para 22). The MCA is a good example of a government in denial, which is why companies like SpeakAsia and TheAdMatrix could pass off spurious ‘surveys’ and ‘ad-clicks’ as ‘products’ to escape the Prize Chits Act.

The MCA also argues that MLMs violate the Prize Chits Act only if the promoters siphon off commissions. This is bizarre when the amount of money siphoned off across the country is probably larger than the 2G scandal. For instance, a company called PACL, running a scheme called Pearls, which claimed investment in agricultural land, reportedly collected Rs20,000 crore (Economic Times, 28 June 2011). There is a long list of others who have raised in excess of Rs1,000 crore. The losses, and consequent public outrage, are so large that politicians, who enjoy a cosy relationship with such companies, have been forced to bring in additional safeguards and legislation to go after unethical MLMs. Even today, most of the work to track such companies is being done by people affected and not by government agencies. A student in Delhi has written to tell us about MLMs posing as software companies that are luring impressionable students wanting extra cash. Another has used the MCA’s own website and company identification numbers (CIN) to trace the fact that the people behind SpeakAsia and TheAdMatrix (two schemes which were luring people almost simultaneously in 2010-11) were working together as far back as 2003. The records show that persons like Manoj Kumar, Rajah P Jain, Renu Sharma and Rajiv Mehrotra, connected with several SpeakAsia entities were running multiple websites together. This only underlines the belief of experts like Mr Sajjanar that there is a core gang that has been changing locations and starting new MLMs.

What then is the remedy? Mr Sarma has identified it comprehensively in several letters to the PM and to the MCA. He has appealed to the PM to designate a nodal ministry to coordinate with the other ministries and regulators, as well as the Enforcement Directorate, Serious Frauds Office, tax and police officials, to ensure proper institutional arrangements to deal with the menace. To the MCA, he wrote: ‘It is not the question of what MCA ‘can’ do.

It is the question of what you ‘should’ do as a responsible Ministry. You cannot be a silent watcher of these fly-by-night operating companies merrily registering themselves, coaxing FIPB or some other agency to legitimise their illegal acts and plunder millions of unsuspecting families. If there is need for a stronger statute, you should take the initiative and act. If there is no coordinated action, it is you who should take the reins and coordinate. Your Ministry is accountable to the Parliament and the people. You cannot be in a perpetually denial mode.”

Will the government respond? Not unless there is public pressure.

Sucheta Dalal is the managing editor of Moneylife. Subscribers get free help in resolving their problems with select providers of financial services. She can be reached at [email protected]